Alfi 2006 by Maison Moderne

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média économique et financier

ALFI - NICSA

15 Annual Europe-USA Investment Funds Forum th

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EDITORIAL

Luxembourg, the centre of reference In 2005, assets under management by the Luxembourg investment fund industry have increased by one billion euros every day of the year! This figure is just as impressive as its aggregate result: Luxembourg has managed to establish itself as Europe’s number one, and the number two worldwide domicile for investment funds, thereby reconfirming its reputation as a centre of excellence for financial services in general and for collective asset management in particular. The Luxembourg Government makes relentless efforts to develop the investment fund industry. An attractive legal and regulatory framework meets the requirements of promoters and investors alike for legal certainty, transparency and efficient supervision. Quick on the uptake to changing market demand, the Government, in close collaboration with the professionals of the sector, has managed to significantly expand and diversify the product range on offer to emerging investment opportunities in the fields of pension funds, real-estate funds, private equity and venture capital funds, hedge funds, etc. The most considerable boost to the development of activities related to investment funds dates back to 1988 when Luxembourg, true to its traditional European and international orientation, was the first country to translate the EU directive on UCITS into national law. Today, the vast majority of funds domiciled here are indeed UCITS funds in possession of the “EU passport” and thereby allowed to reach out to all countries of the EU. Luxembourg has become the centre of reference for cross-border fund distribution and its products have become

Luc Frieden Minister for Treasury and Budget Luxembourg

Illustration: Gerada Rodriguez (www.creativehothouse.com)

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attractive investment opportunities all over the world. It is our strong intention to sustain this success in the long term. The “ALFI-NICSA Investment Fund Forum 2006” will unite speakers from the world’s two leading centres for investment funds. Always eager to learn from the industry’s experience and demands, I look forward to this prestigious event. Allow me to use this opportunity to congratulate ALFI and NICSA for this commendable common undertaking which I am sure will be a complete success! || Luc Frieden

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3 Editorial: Luxembourg, the centre of reference By Luc Frieden, Minister for Treasury and Budget, Luxembourg.

8 Thomas Seale: “Building on sustainable bases” The President of ALFI calls for proactivity and creativity to maintain the quality of the investment funds industry.

16 Exhibition Plan 18 Agenda 20 Keeping the European Fund Industry on top of the game By Hugh Trenchard, Director-General EFAMA (European Fund and Asset Management Association).

22 The changing fund and insurance landscape in North America

38 “Dark clouds on the horizon” By Dr Wolf Klinz, MEP, ALDE Coordinator for Economic and Monetary Affairs, Rapporteur of the European Parliament on Asset Management.

40 Increasing sophistication Interview with Simone Delcourt, Director, Commission de Surveillance du Secteur Financier (CSSF).

42 Luxembourg, the pan-European platform for real estate funds By Emmanuel-Frédéric Henrion and Hermann Beythan, Partners, Linklaters Loesch.

44 Vision of European Fund Industry from U.S. Perspective By Gerard Oprins - Partner - Ernst & Young LLP - Chicago and Michael Ferguson Partner - Head of Asset Management Ernst and Young Luxembourg.

By Tom Hockin, Former President of the Investment Funds Institute of Canada (IFIC), Chairman of the IIFA’s support office and Luxembourg Honorary Consul, Toronto.

26 Looking East By Johnny Yip, Audit Partner Deloitte.

28 MIFID: Fact versus Perception Interview with Stéphane Badey, Senior Legal Counsel for RBC Dexia Investor Services.

30 “Another key challenge is innovation” Interview with John Parkhouse, Partner at PricewaterhouseCoopers Luxembourg.

32 Changes looming on the horizon By Christian Gellerstad, Group Managing Director, Pictet & Cie (Europe) SA Luxembourg.

34 The evolving regulation of Hedge Funds in Europe By Nathalie Dogniez, Partner, KPMG Luxembourg.

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THOMAS SEALE (ALFI)

“Building on sustainable bases” The President of ALFI calls for proactivity and creativity to maintain the quality of the investment fund industry.

Mr. Seale, what do you think of the latest figures for the investment funds sector in Luxembourg? “During the month of May, we saw a fall in volume for the first time since October 2005 (boxed article, page 14). The drop was fairly substantial, in the order of 45 billion euros. But it must be noted that the market effects contributed to more than 64 billion euros. The net capital investment remained positive by almost 20 billion euros. On average, almost one billion euros comes into Luxembourg funds every working day. Are you concerned about these negative market effects? “We have noticed that the markets are concerned. I won’t ring the alarm bells yet, but the good conditions we saw in 2005 will not be repeated this year. Last year everything was favourable: the level of the dollar, the orientation of the markets and investor confidence. This year we are suffering from the instability in the Middle East, the price of petrol, market stagnation and problems in emerging markets… It's like that! We are in a profession where the markets fluctuate. What is important, therefore, is to create here a solid base on which we can build

the future. We cannot build our industry on the strength of the markets alone. Therefore we must build on sustainable bases, have innovative products and develop a financial centre that is favourable for the domiciling of funds. In this way we can continue our work with regard to European and worldwide distribution. These three objectives, which we set three years ago, are still valid today… Is Luxembourg’s strength more in the quality of its legislative environment or in its human skills? “I think that the main advantage is in our capacity to react. Remember what Jack Welch, the former boss of General Electric, used to say: we can’t predict future changes in the environment, but we can be ready to react when those changes occur. Therefore we must be capable of reacting quickly when things happen. This is a good leitmotiv for us, in Luxembourg. We must be able to react when new demands and new products arrive. We have shown proof of this capacity up to now, but it is clearly an ongoing task. This work must also be performed by qualified staff. Isn’t this one of the main difficulties you have to face up to right now? “As a general rule, every generation contributes to the future in its own way. It is absolutely necessary, therefore, that we have young people integrating into the funds industry today. In ten or fifteen years, they will be the leaders. That is why we met the Ministry of National Education and I am happy that we can envisage a certain number of concrete initiatives, with their support, to specifically improve the situation regarding the lack of Luxembourg personnel working in the funds field. We must make people more familiar with this business and above all demystify a [>> 10]

Photo: Andres Lejona

On the occasion of this 15th Europe-USA Investment Funds Forum, jointly organised by ALFI and NICSA, Thomas Seale, President of the Association of the Luxembourg Fund Industry, host of this international event, takes an uncompromising look at the development of an industry in which Luxembourg excels. In recent years expertise and reactivity were the engines of growth in the investment funds sector in the Grand Duchy. But there is no question of resting on laurels. “It is clearly an ongoing task,” he stresses.

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SINCE 1988

ALFI, who are you? ALFI (Association Luxembourgeoise des Fonds d’Investissement) is the official representative body for the Luxembourg investment fund industry and was set up in November 1988 to promote its development. ALFI’s Articles of Association were amended in April 2000 and, as well as investment funds, the association now includes a wide selection of service providers: custodian banks, fund managers and administrators, transfer agents, fund distributors, law firms, consultants and tax advisers, auditors and accounting firms, IT services companies, etc. Its mission is to “Lead industry efforts to make Luxembourg the most attractive international centre for investment funds”. ALFI plays a proactive role in leading industry efforts to turn Luxembourg into the most attractive international centre for domiciling and distributing investment and pension funds and the main gateway to the European and global fund markets. The four main objectives of the association are: - to help members capitalise on industry trends, by providing a framework for information sharing via meetings, the Internet and the Association’s annual conferences and promoting the visibility of its members; - to shape regulations, by working actively with the supervisory body, the government and law-makers when writing EU directives into national legislation or creating a regulatory framework for specific products so as to defend Luxembourg’s competitive advantage as an investment fund centre; - to encourage professionalism, integrity and quality, by offering training and skills enhancement to industry professionals, by drafting a code of good conduct, transparency and corporate governance and by supporting the fight against money laundering; - to promote the Luxembourg fund industry, by maintaining close relations with political and economic policy-makers at national and European level, by supporting the industry’s efforts to develop new products, by representing the sector in the context of global economic missions, by participating actively in industry gatherings at world level and by building up proactive national and international press relations. The Board of Directors is composed of 24 members representing investment funds and service providers from six countries in two continents. The international and multi-disciplinary nature of the Executive Committee and the close to 50 technical committees and working groups coordinated by the General Secretariat provides the basis for developing valuable synergies. || 10

sector that is, for many, still far too technical. When we speak of the steel industry, everybody knows what steel is. This is not the case with investment funds. We want secondary level school students to take more interest in our sector. Currently, in the company I manage, (NB: European Fund Administration, a company specialising in fund accounting and transfer agent services, with 450 staff and which manages more than 100 billion euros of assets), I have no less than 20 positions to fill. But no Luxembourg nationals are applying for them. Investment funds are, nevertheless, one of the rare sectors in which Luxembourg has a globally recognised leadership position.. But does this international recognition attract skills from abroad, even beyond the European Union? “People do not know Luxembourg outside the Grande Région. Therefore, they do not necessarily have a desire to come here. It is mostly customers who are management companies who are increasingly saying that “Luxembourg is the place to be”. But often they rely heavily on existing Luxembourg service providers. This means that it is the whole Luxembourg infrastructure, i.e. the banks, legal experts and supervisory

authority, that must obtain the resources and the skills to serve these customers. This is another challenge to be met and I have already said a number of times that we should be more flexible with immigration in Luxembourg. We must be more proactive in attracting people who want to come here to work, even if they come from a country outside the European Union. In this respect, I was very satisfied to see that the government has recently promised some flexibility in the processing of applications from persons from the new E. U. Member States who wish to work in a company in the financial sector in Luxembourg. I can only congratulate it for having had the courage to take this initiative. It is a first step and a good starting point for going further. In effect, I would like us to be more proactive – to imagine, and why not, physically going to the heart of these new States, saying: “We have 300 positions to fill, come work for us.” What about the training aspect? Isn’t this also one of the means that needs further development? “This is a third axis on which we are actively working. Moreover we have just signed a partnership with the Institut de Formation des Banques, Luxembourg (IFBL) in order to implement more courses for the OPC (Organismes de

Tom Seale: “If the demand is there, but not the supply, wages will rise. We must, therefore, be capable of ensuring an appropriate and sufficiently qualified supply to be able to control the wage/price spiral…”

Photo: Andres Lejona

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Placement Collectif – similar to Unit Trusts in the UK or Mutual Funds in the US) sector. So things are happening and we are working aggressively. But we have not yet reached the end of the road. Every time I hear “we must pay attention to costs”, I understand very well what is being said. But the only way for me to manage the cost aspect is to manage the law of supply and demand. If the demand is there, but not the supply, wages will rise. . We must, therefore, be capable of ensuring an appropriate and sufficiently qualified supply to be able to control the wage/price spiral…

NICSA, who are you? The National Investment Company Service Association (NICSA) is a not-for-profit trade association providing leadership and innovation in educational programming and information exchange within the operations sector of the worldwide investment industry. NICSA membership totals more than 400 companies operating in major financial centres in the United States, Europe and Asia. The membership represents all segments of the mutual fund industry including mutual fund complexes, investment management companies, custodian banks, transfer agents and independent providers of specialised products and services. NICSA’s services to members include education, training and networking opportunities through conferences on a wide range of industry issues and developments; specialised publications, such as the Transfer Agent Compliance Check List, and access to NICSA’s membership directory. NICSA also offers an On-Line Learning Centre featuring the Certified Mutual Fund Specialist Programme, the first-ever certification programme of its kind. NICSA’s mission is to provide educational networking and programming, as well as to provide a forum for the discussion and distribution of information to the membership by: - achieving recognition as a leader in the delivery of high-quality educational and informational programmes; - creating an environment that encourages free exchange of ideas among members; - developing improved methods and practices to meet current and future needs of the industry; - advocating for uniform procedures and standard practices that take advantage of the most appropriate technology. || 12

What was the contribution of the UCITS III legislation to the funds industry in general and to Luxembourg in particular? “It is clear that UCITS III gave a new momentum to the entire industry in Europe, as it gave more flexibility at the management level. It is, therefore, a good thing. Everybody benefited and my feeling, as regards Luxembourg, is that the sector is today reaping the rewards of a certain number of years of effort during which we multiplied our contacts with foreign promoters, but also with the authorities of other countries to talk to them and explain our vision.

How do you live with the competition with the United States, the leading world market? “The two markets are completely different, insofar as the American market, which is vast and very efficient, is purely domestic while we are, conversely, internationally focused. Here also the view of professionals has changed in recent years. There is a feeling that a page has genuinely been turned. Has the cooperation you have developed with NICSA encouraged exchanges between Americans and Luxembourg or even European nationals? “These exchanges are very positive. Moreover, we signed an agreement two years ago to make our relationship more formal. We participate once a year in a conference organised by NICSA in the United States and when we conducted our promotional tour last year, they provided their support to our road shows.

UCIs: Distribution according to legal form (left) and to law and part applicable (right) Situation as at 30 june 2006 1% 9% 46%

14%

25% 53% 52% Source: CSSF

SINCE 1960

Some years ago, Luxembourg was often the subject of criticism, with people thinking that we were always pushing the envelope of the European Directives. Today, when we talk to the same promoters, everybody acknowledges our dynamism, but also the capability of the supervisory authority. This creates genuine trust.

FCP Sicav Others

Part I (law 1998) Part I (law 2002) Part II (law 2002) Institutional UCIs

Striving for perfection.

Business process outsourcing solutions for the financial industry.

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This relationship is one of the pieces of a much bigger jigsaw. Obviously I am very satisfied to see that it operates very well, but we have a number of links between here and the United States. We should not forget, for example, there are also firms present in Luxembourg who often have subsidiaries, sister companies or partnership practices on the other side of the Atlantic. This helps greatly in the quality of exchanges.

UCI IN LUXEMBOURG

+8.32% between December 2005 and June 2006 As of 30 June 2006, total net assets of undertakings for collective investment reached 1,652.126 billion euros compared with 1,657.677 billion euros as of 31 May 2006. The Luxembourg undertakings for collective investment sector decreased by 0.33% compared with May 2006. This fall is mainly due to the drop in the main stock markets. Close to half of these assets (712.95 billion) are invested in fixed-income transferable securities (including 202.04 billion euros in money market instruments and other short-term securities). Investment in variable yield transferable securities (including 2.65 billion euros in non-listed transferable securities and 0.38 billion euros in venture capital) rose to 633.01 billion. In June 2006, the sector increased by 8.32% compared with 31 December 2005 when the total net assets amounted to 1,525.208 billion euros. Over the last twelve months, the volume of net assets rose by 28.09%. During the month of June 2006, net disinvestment amounted to EUR 1.994 billion. Compared with 31 December 2005, net capital investment totals EUR 153.565 billion. The number of undertakings for collective investment taken into consideration totals 2,130 against 2,113 in the previous month. A total of 1,336 UCIs have adopted the multiple compartment structure, which represents 8,115 compartments. When adding 794 UCIs with a traditional structure to the previous figure, a total of 8,909 compartments are active in the financial centre. Fund promoters in Luxembourg come primarily from three countries which represent more than 60% in total: Switzerland and the United States share first place (19% each), in front of Germany (16.5%), far in front of Italy (10.3%) and the United Kingdom (9.9%). || 14

What do you expect from this 15th Europe-USA Forum in Luxembourg? “Generally, these conferences are used to help the industry, in its entirety, to explain the recent trends developing in the sector. The other interest is, evidently, in the networking between the conferences and around the exhibition stands. Luxembourg’s strength, that capacity to react quickly that I mentioned earlier, can only function if the industry, in its entirety, remains intact and integrated. This type of conference is extremely important so that the participants in the sector know each other and can discuss the subjects that interest them between themselves. A few weeks after this type of event, we often see an avalanche of new ideas for which wor-

king groups are set up within ALFI. It’s always very productive... We also organise a major international conference in the spring and these two meetings have become an absolute must and are noted in everybody’s diary. Two conferences of this type during the year is a very good rhythm to ensure that there is always something interesting for top quality speakers to say. Not forgetting the aspect of the pure “promotion” of the financial market… “We have always stressed that every effort should be made to attract the maximum number of persons from abroad to these conferences. They represent approximately onethird of the conference participants. It is, of course, very important publicity for the Market. Don't forget that the people who come spend two or three days here. They can evaluate the hospitality infrastructure, the quality of Luxembourg City and the dynamism of the sector's professionals. At any rate, I have always said that conferences of this type are an integral part of the Market promotion efforts. Without losing sight of the fact that while promotion is one thing, there must obviously be substance behind it.” || Interview recorded by Jean-Michel Gaudron

Net assets and entities in Luxembourg from June 2005 to June 2006 entities 2150

in bn EUR 1700 1600

2100

1500

2050

1400

2000

1300

1950

1200

1900

1100

1850

1000

1800 05 y 05 g 05 t 05 ct 05 v 05 c 05 n 06 b 06 r 06 r 06 i 06 n 06 jun ju O Ja Ap De Ma Fe No Au jul Ma Sep

Net assets

Number of UCIs

Over the last twelve months, the volume of net assets of UCIs in Luxembourg rose by 28.09%.

Source: CSSF

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15 Annual Europe-USA Investment Funds Forum Exhibitors Plan

HEMICYCLE (SESSIONS)

SPEAKER LOUNGE PRESS ROOM JUICE BAR F 13 17 21 A 6 4 20 12 18 1 3 19 D 8 2 14 E C 10 22 5 B 9 11 7 16 15

AB Prodata ABN AMRO Mellon ALFI/IFBL Alpheus Aquin Components GmbH BNP Paribas Securities Services Luxembourg CACEIS CCLux Co-Link S.A. Confluence Ernst & Young Luxembourg S.A. Fortis Banque Luxembourg FundConnect GCom2 Solutions IGEFI (Luxembourg) S.A. Interactive Data (Europe) Ltd. JPMorgan Chase Bank NA KOGER, Inc. KPMG Luxembourg Kremer Associés & Clifford Chance Morningstar tbc PricewaterhouseCoopers Sàrl Profidata AG RBC Dexia Investor Services Bank S.A. SimCorp Benelux S.A. State Street Bank Luxembourg S.A. Tieto Enator UBS Fund Services

13 12 11 10

14 15 16 17 18 19 20 21 22

ENTRANCE (stairs & lift/Level 0)

INFORMATION DESK

TEA BAR 7

COFFEE BAR TELINDUS INTERNET CORNER

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T H E 1 5 TH A N N U A L E U R O P E - U S A I N V E S T M E N T F U N D S F O R U M

Conferences programme T U E S D AY, 2 6 S E P T E M B E R 2 0 0 6

8 .0 0 - 9.0 0 A . M .

1 0. 3 5 - 1 1 .0 5 A . M .

2 . 5 5 - 3 . 2 5 P. M .

Registration and breakfast

Refreshment break and visit of the exhibition area

The transformation of savers back into investors in the land of the rising sun

9.0 0 - 9. 1 5 A . M .

Opening remarks Barbara Weidlich, President, NICSA, Marlborough

1 1 .0 5 - 1 1 . 3 5 A . M .

Meeting the needs of the Middle Eastern investors Nicolas Trad, Senior Banker Middle East, Calyon, Kingdom of Bahrain

Dean Maines, Managing Director of Deloitte & Touche Overseas Services LLC, Southeast Asia Investment Management Leader, Tokyo

3 . 2 5 - 3 . 5 5 P. M .

Refreshment break and visit of the exhibition area

Thomas Seale, Chairman, ALFI and CEO, European Fund Administration – EFA, Luxembourg 1 1 . 3 5 - 1 2 .0 5 A . M .

3 . 5 5 - 5 . 1 0 P. M .

Latin America - Opportunities for Luxembourg funds

Hong Kong, Taiwan, South Korea and Singapore: The next frontier for the distribution of Luxembourg investment funds?

9. 1 5 - 9. 3 0 A . M .

The conclusions of ALFI's marketing trip Joseph Sweigart, Managing Director, Latin America and Offshore, JP Morgan Asset Management, New York

Changes in the Luxembourg fund industry Simone Delcourt, Director, Commission de Surveillance du Secteur Financier, Luxembourg

1 2 . 1 0 - 2 .0 0 P. M .

Luncheon and address 9. 3 0 - 9. 3 5 A . M .

Peggy C. Schooley, Chairman, NICSA and President, Evergreen Service Company, Boston

Chairman's introduction Gerard Oprins, Partner, Ernst & Young LLP, Chicago

Moderator: Noel Fessey, Managing Director, Schroder Investment Management (Luxembourg) S.A.

Panellists: Mark Browning, Managing Director (East Asia), Franklin Templeton Investments, Seoul Marco Zwick, Compliance and Risk Director, Schroder Investment Management (Luxembourg) S.A.

Luncheon hosted by Ernst & Young and State Street 9. 3 5 - 1 0. 3 5 A . M .

2 . 1 0 - 5 . 1 0 P. M .

Our industry - Where it stands today and perspectives for tomorrow

Hong Kong, Taiwan, South Korea, Singapore and Japan: The next frontier for the distribution of Luxembourg investment funds?

John Parkhouse, Partner, PricewaterhouseCoopers, Luxembourg

2 . 1 0 - 2 . 1 5 P. M .

Introduction John Stadtler, Partner, PricewaterhouseCoopers, Boston

Geoffrey Cook, Managing Director, Luxembourg and Global Head of Fund Administration, Brown Brothers Harriman (Luxembourg S.C.A.) Gast Juncker, Partner, Elvinger, Hoss & Prussen, Luxembourg

Noel Fessey, Managing Director, Schroder Investment Management (Luxembourg) S.A. 5 .4 5 - 7.4 5 P. M .

Cocktail Reception Erwin Schoeters, Managing Director, KBC Asset Management, Brussels

Al Falcone, Senior Vice President Fund Operations and Services, IXIS Asset Management Global Associates, Boston

2 . 1 5 - 2 . 5 5 P. M .

Political and strategic challenges and opportunities: Hong-Kong, Taiwan, South Korea and Singapore François Heisbourg, Chairman, International Institute for Strategic Studies (London)

Espace Agora, Centre Culturel de Rencontre – Abbaye de Neumünster, 28, rue Münster, Luxembourg-Grund Reception hosted by PricewaterhouseCoopers Luxembourg Buses will depart from the Conference Centre at around 5.30 p.m.

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W E D N E S D AY, 2 7 S E P T E M B E R 2 0 0 6

8 . 1 5 - 9.0 0 A . M .

1 0. 5 5 - 1 1 . 5 5 A . M .

3 . 1 0 - 3 . 3 5 P. M .

Registration and breakfast

Luxembourg on the REIT track: Opportunities for the Luxembourg fund industry – Real estate funds

What did UCITS III really mean with regard to creating new products – The practical view from an international asset manager

9.0 0 - 9.0 5 A . M .

Chairman's introduction

Mike Hornsby, Partner, Ernst & Young, Luxembourg

Christian Gellerstad, Group Managing Director, Pictet & Cie (Europe) S.A., Luxembourg

Anne Bon, Legal Advisor, Axa Asset Investment Managers, Paris

Hermann Beythan, Partner, Linklaters Loesch, Luxembourg 9.0 5 - 9. 2 0 A . M .

3 . 3 5 - 4 .0 5 P. M .

Opening Address

The Prospectus Directive: Opportunities for EU distribution of non-UCITS products?

The Honorable Ann L. Wagner, Ambassador of the United States of America to Luxembourg

Peter Cassells, First Vice President, Fund Manager, ProLogis Management Sàrl, Luxembourg

9. 2 0 - 9. 5 0 A . M .

Changing landscape of the North American fund industry Tom Hockin, Former President of the Investment Funds Institute of Canada (IFIC), Chairman of the IIFA’s support office and Luxembourg Honorary Consul, Toronto 9. 5 0 - 1 0. 2 5 A . M .

MIFID - Implications for fund promoters in Europe Gareth Adams, Executive Director – Regulatory Strategy, Fidelity International

1 0. 2 5 - 1 0. 5 5 A . M .

Refreshment break and visit of the exhibition area

1 2 .0 0 - 2 .0 0 P. M .

Claude Niedner, Partner, Arendt & Medernach, Luxembourg

Neal McKnight, Partner, Sullivan & Cromwell LLP, London

Luncheon Luncheon hosted by BNP Paribas Securities Services and Deloitte 4 .0 5 - 4 . 1 0 P. M . 2 . 1 0 - 3 . 1 0 P. M .

Chairman's closing remarks

Gearing up targeted improvements to European fund legislation

4 . 1 0 - 5 .0 0 P. M .

Moderator: Thomas Seale, Chairman, ALFI and CEO, European Fund Administration – EFA, Luxembourg Panellists: Niall Bohan, Head of Unit Asset Management, DG Internal Market, European Commission, Brussels Dr Wolf Klinz, ALDE Coordinator for Economic and Monetary Affairs, European Parliament, Brussels

Gary Palmer, Chief Executive, DFIA Dublin Funds Industry Association, Dublin

Elizabeth Corley, Chief Executive Officer, Allianz Global Investors Europe GmbH, Munich

Champagne reception Hosted by Mercuria Services

T H U R S D AY, 2 8 S E P T E M B E R 2 0 0 6 H E D G E F U N D CO N F E R E N C E ( A L F I & A I M A )

Alternative Investment Conference – Developments in Hedge Fun Strategies, Risk Management and Portfolio Administration Chamber of Commerce 7, rue Alcide de Gasperi L-2981 Luxembourg-Kirchberg Info & Contact: ALFI +352 22 30 26 1; info@alfi.lu; www.alfi.lu

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HUGH TRENCHARD

Keeping the European Fund Industry on Top of the Game The European Fund and Asset Management Association (EFAMA) continues to work for the improvement of the European legislative framework with a goal of keeping Europe’s fund industry the best in the world.

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

Hugh Trenchard Director-General EFAMA (European Fund and Asset Management Association)

Following this ALFI-NICSA conference, ALFI will also host the “Hedge Fund Conference”, organised jointly with the Alternative Investment Management Association (AIMA). We at the EFAMA recognise the growing significance of hedge funds and funds of hedge funds, as investor awareness and interest in these products increases and the dividing lines between “traditional” and “alternative” asset management strategies become increasingly blurred. I am confident that this conference will also attract great interest and make a useful contribution to the development of the alternative sector. Luxembourg’s importance to the investment fund industry in Europe, and in the wider world, owes much to its early recognition of the potential of maintaining a relatively benign, stable tax regime and a ‘light touch’ regulatory framework. In particular, Luxembourg developed a reputation for excellence in the provision of administrative and ancillary services for funds, including custodian and depositary services. The legal and accounting professions here also grew in size and stature. Luxembourg-domiciled funds have maintained a strong, positive, safe image which predates the UCITS Directive of December 1985. I remember well, as an investment

banker in Japan in the 1980s, the blank looks on the faces of my Japanese investment clients when I suggested the Channel Islands as a good place in which they could incorporate a fund. The normal riposte from the clients came quickly: “But don’t you think Luxembourg would be better? We feel comfortable with Luxembourg.” In an age of greatly increased personal affluence, collective investment schemes have emerged as the standard method in many countries whereby individuals can invest their growing assets in a range of investments, until recently mainly restricted to bonds and equities, but now also including derivatives and other types of securitised assets. At first only a small proportion of investors held assets outside their own countries but with the globalisation of the economy and financial markets it may be argued that it lessens rather than increases risk for most individuals to hold assets abroad and denominated in different currencies. The European fund industry’s trademark product, the UCITS, has been a tremendous success. Accounting for nearly 80% of the total European funds market of approximately 6.6 billion euros at the end of 2006, total assets under management in UCITS have more than quadrupled since 1995.

This achievement is the more remarkable as it took place during a period which encompassed one of the more severe stock market collapses in history. Equity funds now account for around 39% of all UCITS funds by value, with balanced funds accounting for another 13%. Bond funds comprise around 25% and the remainder is divided between money market funds and funds of funds. A notable trend since 1998 has been the growing importance of cross-border funds. Luxembourg-domiciled funds received 61% of total net inflows to UCITS in 2005 and is now the clear market leader in terms of domicile, accounting for 26.8% of UCITS total assets and 23.2% of all European funds. In recent years, Ireland has also presented Luxembourg with a serious challenge as a fund domicile and has risen rapidly from a low base to account for 8-9% of European funds. Looking forward, the EFAMA will continue to work for the improvement of the European legislative framework to facilitate a true single market. We look forward to the publication of the European Commission’s White Paper this coming November. It is essential that steps are taken to provide for a simplified prospectus which must be both simple and standard. We also need to see improvements to the notification procedure for cross-border marketing of UCITS. We expect that CESR should adopt a more positive approach to this subject than it has done so far. We also would like to see a workable framework for the operation of management company passports and the introduction of measures designed to facilitate pooling and mergers of funds. Above all, the EFAMA is committed to preserve the competitiveness of the European investment fund industry. This will require a review of the Savings Tax Directive which is now driving new investments away from UCITS, both into nonUCITS products and indeed to other financial centres such as Dubai and Singapore. It is also essential to keep strict regulatory rules to the minimum whilst concentrating on continuous improvement of ‘light touch’ principles based on regulation which provides effective investor protection but does not stifle product innovation and investor choice with unnecessary, burdensome and expensive red tape. I look forward to assisting the EFAMA play its part in achieving our objectives and ensuring that Europe’s fund industry remains the best in the world. || Hugh Trenchard

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TOM HOCKIN

The changing fund and insurance landscape in North America I will reflect more on US developments, but I can’t resist a few comments on the Canadian scene where I headed the Canadian Investment Funds Institute for 11 years until March of 2006. My first set of comments tries to give some perspective on the so-called “waning” of the mutual funds industry in North America. A few facts tell a dazzling tale. As the 1990s began, US funds investing mostly in the stock, bond and money markets, passed a milestone. Their assets hit one trillion US dollars, ten times where they had stood a decade before. The story had just begun. By the middle of this decade, US funds held more than nine trillion US dollars, according to the Investment Company Institute. Worldwide fund assets were approaching 18 trillion US dollars (more than half a trillion US in Canada) as growth got rolling – even faster outside the United States. All along the way, wise heads kept assuring everyone that this couldn’t keep happening. “Just about every ten years, some expert delivers a speech stating that the mutual fund industry has fully matured, and at best will grow at a snail’s pace in the future,” said Matt Fink, retired president of the ICI, speaking at a recent fund conference in Boston. At the ICI’s annual meeting in 1977, Fink recalled; a prominent professor warned that the business “has seen its great growth years.” In 1997, another leading academician declared that “the structural attractiveness of this industry is inevitably going to decline.” In 2000, a learned journal proclaimed “the death of mutual funds.” As Fink observed, “Prophesy is risky business.” As Chet Currier of Bloomberg News reminded us the other day, “The prophets may have gone wrong in this case, as they so often do, by taking a static, or two-dimensional, view of what was actually a dynamic, or three-dimensional situation. Static analysis tends to miss important forces such as the multiplying power of growth”. In a static view of things, a growth area like funds expands by taking business from others in this example banks, insurance companies, and so forth. Also, funds have benefited might-

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

There is nothing as difficult as trying to predict the future, and that is especially true when speaking about any area of investment. Still, there are lessons that the fund industry can learn from the past.

Tom Hockin, Former President of the Investment Funds Institute of Canada (IFIC), Chairman of the IIFA’s support office and Luxembourg Honorary Consul, Toronto

ily from the ascendancy of individualised retirement savings vehicles such as 401(K) plans at the expense of conventional “defined benefit” pension plans. The banking, insurance and pension management businesses “didn’t shrivel up and vanish” as Currier reminds us. “Somehow, the whole pie got much bigger. While enjoying the benefits of growth, funds helped to make it happen”. Their great success hasn’t proved to be a static event either. It has opened the door to

new competition from alternative vehicles including hedge funds, exchange-traded funds and separately managed accounts. All are pushing hard for new opportunities in a burgeoning mass market for investing and money management. This summer in Canada, with the foreign content rule for registered investments being abolished, international mutual funds have seen increased sales. Also in this dynamic environment, new entrants (besides mutual funds) have thrived without destroying the growth of mutual funds.

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Consider too how ideas have changed about what constitutes a “big” mutual fund. A decade or two ago, one billion US dollars in assets was considered too big to be nimble. Today, at the top of fund lists we have Capital Group Cos.’ 142 billion US dollar Growth Fund of America in Los Angeles, which according to Bloomberg data, has handily beaten the Standard & Poor’s 500 index over the past year, the past three years, and the past five years. A similar, expandable model could prove a useful way right now to view the overall global economy. Such a perspective makes room for positive bursts of wealth resulting from increased world trade, stepped-up productivity in China, and the emergence of new consumer societies in countries all over the map. I believe the dynamics of global growth will confound experts in the years ahead, in the same way they repeatedly fooled the experts who study mutual funds. So there is my exhilarating first point. My second set of comments adds up to a cautionary, not pessimistic, note. I will articulate what I see as the key new challenges for investment funds and the technological innovations all this calls for. We are – as recent players and observers (see the Special Edition of IGNITES for 2006 ICI General Membership Meeting) have noted – at an embryonic stage in meeting the challenges in North America (and I reckon) in the rest of the world. In the US and Canada with 80 million baby boomers at or near retirement age with an established 15 trillion dollars (US) up for grabs, the financial services industry is facing the opportunity of a lifetime. As competition for retirement dollars heats up, many fund complexes find themselves already a step behind other industries that are also competing in the same space. Fund firms have yet to find a secure footing in the retirement income landscape. “I think they’re feeling insecure about the future”, says John Curry, managing director of retirement management firm Fund-Quest.

“I think funds firms do have a special dynamic going on that is troubling them. Distributors are going to control the client experience, they are going to set the tone. Manufacturers are behind the curtain,” Curry says. In essence I see four avenues fund firms should explore if they want to position themselves in the retirement income space. They include education, marketing, products and services. When it comes to education, fund firms have a unique opportunity to be “thought leaders” and to roll out educational processes that add value to advisors who are working to help clients plan for retirement income, Curry says. Some firms, such as Fidelity, Vanguard, T. Rowe Price, Oppenheimer Funds, Putnam and Columbia Management, have already gained a foothold in the retirement income marketplace and are arming intermediaries with solutions to help them advise their clients about retirement income planning. Here we have according to Curry, “a true opportunity to add value for advisors to help them frame the issues.” Columbia has launched a service called the Columbia Management Retirement Learning Center. The service is a support programme for financial advisors and other intermediaries looking to provide clients with retirement and roll-over strategies. Columbia is providing this service via an exclusive partnership with the Retirement Learning Center, an organisation of retirement information specialists based in Brainerd, Minn. In June of 2005, Oppenheimer Funds launched its so-called Retirement Income Manager, a software tool that allows advisors to assess a client’s probability of meeting income needs during retirement based on the client’s current situation. Fund firms also have a part to play in developing products for boomers’ transition from wealth accumulation to wealth harvesting. In my view, insurance companies in North America have gained a better positioning at the starting gate when it comes to the development of retirement income products. That’s because

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insurance firms already have products in place that can be geared toward meeting the income needs of retirees, such as immediate income annuities. These products can provide investors with a lifetime income stream that they are guaranteed not to outlive. I see room for both fund firms and insurance companies on the product development side of the retirement income landscape. While insurance products will appeal to the mass market, wealthier investors will look more to investment management when it comes time to plan their retirement income. In Canada a top-notch data-mart provided by TICOON in Toronto Ontario perhaps points the way to do all this through a potential link up with the insurance industry. TICOON provides data – with the clients’ permission – of all of the customer’s financial assets for the advisor, such as bank balances, mortgage balances, securities, funds, cash value of insurance and pensions and so on. This can be engineered to provide the sort of wealth harvesting the fund industry is talking about (but not yet doing) along with the insurance industry and its products. OLYMPIC in Europe and MIDIS in Luxembourg offer integrated bank platforms. SUNGARD has a family office software. The Institute for Private Investing in Europe champions these efforts at integration. Let’s look at a few examples of the richness of offerings by the fund and insurance industry in the US, somewhat reflected also in Canada. One product will see fund complexes gravitate toward so-called “future denominated” income products. These will be lifetime income products made up of mutual funds, separate accounts or annuities. “These products only exist in the annuity world today,” says John Carl of the Retirement Learning Centre, “but you will see these types of products being offered in the form of mutual funds or separate accounts.” A third area is marketing fund complexes with focused marketing materials which will be less “accumulation-centric” and more oriented

toward retirement income. For example, on US 401(k) or Canadian RSP statements, fund companies can show investors how their balances will translate to retirement. As always we will see firms roll out services to advisors for helping their clients plan for retirement income, or pitch them directly to investors, as Fidelity has done with its Retirement Income Advantage. Fidelity’s Retirement Income Advantage offers Web-based retirement income planning tools directly to investors. Bonnie Bauman of IGNITES observes that fund firms have an important role to play in the retirement income arena, yet “for the most part, fund shops are behind the curve”. This is “what everybody is talking about,” she says. “The question is: What are people doing? Many appear to be just talking – and they will be left behind. The reality is that the first of the baby boomers turn 60 this year. With an average retirement age of 62, we’re still two years away from the leading boomers’ retirement. This is going to take a while to unfold; and this is something the fund industry is going to be working on for a long time.” A word then about the insurance industry in the upcoming era of “wealth harvesting”. In 2005, net flows amounted to only 20.5 billion dollars for variable annuities in the US, a 50% drop from 2004. A similar fall-off occurred in Canada. Still analysts say the industry is looking at ways to leverage its strength in providing protection, risk management and guarantees, not just to attract new capital but also to become a bigger player in the retirement income race. “As an insurance industry, we need to broaden our vision of the space that we compete in,” says Bob Boyda, senior vice president of investment management services at John Hancock Financial Services. “We have to think about it more globally as the entire retirement income pool, not just the annuity space.” VAs, with 1.5 trillion dollars in assets in North America, make up just a fraction of the estimated 15 trillion in retirement dollars potentially up for grabs in Canada and the US.

Yet, I would suggest, VAs, and annuities in general, are in a unique position to respond to needs of retirees. VAs can generate income for life that’s both adequate and sustainable. From annuities to living benefits, it is clear the industry is working to provide insured income in whatever form it takes. In recent years, it has come mostly in the form of living benefits. According to Ernst & Young, 85% of VAs sold today offer some type of living benefit. Among these, the guaranteed minimum withdrawal benefit, or GMWB, has spawned the most variations. They have taken the lead in offering solutions that combine the different options available in both deferred and immediate annuities. The GMWB for Life, which guarantees a monthly income for life, and GMWB for Life 2, which extends that to a contract owner’s spouse, has multiplied in the marketplace. At the product level, insurers may offer insurance wraps on different investment vehicles or unbundle their GMWBs and sell those on separately managed accounts. (Of course challenges exist on the capital requirements for these types of products and their riders that are fuelling consolidation in the industry.) I warn however, in the rush to develop new products, to not build complexity and sacrifice simplicity. I agree with Bob Boyda, of John Hancock, who warns that VAs need to reach the same level of simplicity that advisors are used to dealing with when they deal with mutual funds. To conclude, the fund industry is far from dead! It is partly a driver and partly a beneficiary of the three-dimensional growth of the financial industry for retirement accumulation and harvesting in North America. It is clear from what I have touched on above, that dramatic new opportunities are ahead and technology is evolving to meet these challenges. It is not clear, however, that the fund industry has glimpsed what it can do to reap its proper reward and provide the solutions. Technology providers should concentrate on this. The rewards are multi-dimensional and unprecedented! || Tom Hockin

nordea_pj_22.9_238x300.fh10 12.09.2006 14:29 Uhr Seite 1 C

CY CMY

Voir le présent, prévoir l’avenir

Nordea 1 – Nordic Equity Fund (ISIN: LU0064675639) Les évolutions sociales et structurelles, qu’il s’agisse du développement rapide de la technologie, des transformations du paysage démographique ou de la globalisation des marchés déterminent à quoi la région Nordique de demain ressemblera. Nos gérants analysent la dynamique sectorielle et les mutations structurelles afin d’identifier les sociétés les

mieux placées pour bénéficier de ces évolutions. Ils sont capables d’analyser ces tendances et d’offrir une meilleure performance sur le long terme. Tels des recruteurs à la recherche de nouveaux talents, ils analysent le marché d’un angle différent en créant ainsi un avantage gagnant.

Making it possible*

www.nordea.lu * Rendre possible Nordic Equity Fund est un compartiment de Nordea 1, SICAV, une société d'investissement à capital variable à compartiments multiples de type ouvert de droit luxembourgeois. Les investissements dans les compartiments de Nordea 1, SICAV ne peuvent être effectués que sur la base du prospectus actuellement en vigueur, ainsi que les actuels rapports annuel et semestriel. Ces documents ainsi que les prospectus simplifiés sont disponibles sur simple demande et sans frais auprès de Nordea Investment Funds S.A., 672, rue de Neudorf, B.P. 782, L-2017 Luxembourg et auprès de nos distributeurs. Une transaction comportant des opérations de change peut être sujette à des fluctuations du taux de change qui peuvent affecter la valeur d'un investissement. Les investissements effectués sur les marchés émergeants impliquent un risque plus élevé. Publié par Nordea Investment Funds S.A. à Luxembourg.

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JOHNNY YIP

Looking East Asia is not only a fascinating region but also an increasingly important centre for entrepreneurship and investments. Although the majority of the population are from rural areas in China and India, their economies are driving the growth in Asia and are influencing change throughout the world according to their rhythm. Up until now, cross-border distribution of Luxembourg investment funds in Asia has been concentrated mainly in Japan and Hong Kong. Since the 1990s, Luxembourg has been successful in attracting Japanese promoters and asset managers to establish funds here with reported net assets under management of 26 billion euros (source: Commission de Surveillance du Secteur Financier, 30.06.06). The funds are mainly institutional under the 1991 law. On the retail side, many Luxembourg investment funds are distributed in Japan, Hong Kong, Singapore, and Taiwan with varying degrees of success. Retail distribution in Hong Kong has not been an easy start for Luxembourg. Thanks to the intervention of the industry the process was streamlined in the 1990s. Recently, the Hong Kong Securities and Futures Commission (SFC) issued the longawaited circular to facilitate the distribution of UCITS III funds. In general, the information on risk management and control process required by the SFC is more or less the same as the one requested by the CSSF in the UCITS III context. It is also important to mention that Luxembourg funds offer various funds investing in Asian securities such as the “China Fund” or the “India Fund”, and a significant part of the assets are invested in these funds. The real question is what can the Luxembourg investment fund industry do to attract more assets from Asia? There is potential for Luxembourg to leverage the existing know-how and infrastructure of the industry. Most of the asset managers operating in Luxembourg are also established in the fast growing economies such as China and India and we should intensify the efforts to make our products known and well understood.

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

Has the Luxembourg investment fund industry been too busy looking to US and European markets to leverage the potential of Asia?

Johnny Yip, Audit Partner Deloitte

Institutional investors, such as insurance companies, pension funds and private equity should be a priority target because of their accessibility. Regarding China currently, Qualified Domestic Institutional Investors (QDIIs) can invest outside China, and the retail market has future potential for Luxembourg funds if China continues to open its domestic assets to invest abroad. It is important to understand the cultural influences in order to understand how the people invest or how to facilitate change. For example, a heavily rural population that is now aging is influenced by traditional Chinese saving. A younger urban Chinese population may be more adaptable to newer ideas concerning savings and investment. Collective investments are growing although there is a cultural “betting” short-term view. Individual investors, institutions and high net worth individuals are increasing. Currently, Luxembourg harbours mutual funds promoted by 16 out of the 23 asset

managers who have a Chinese partner in joint venture fund management companies in China. The Luxembourg know-how for crossborder mutual funds distribution is well positioned to tap the vast savings markets in the long term. What are the specific advantages of Luxembourg for the institutional investors in Asia? Innovation and variety of products are two recognised advantages we have over other jurisdictions. These apply not just for the investment fund industry but also for the financial industry as a whole. At the start, Luxembourg offers a tax-neutral system that has inspired the business community around the world to operate here. Secondly, a prolific regulatory system has made it possible to create a multitude of products and legal structures. As mentioned above, the 1991 law has attracted many Japanese promoters to Luxembourg. The forthcoming update of this law will enhance our

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attraction for institutional investors looking for alternative investments such as hedge funds and real estate. In particular, Luxembourg is well positioned to domicile funds, and funds of real estate funds, for investments in real estate in or outside Asia. Over the past years the major players in properties and real estate have set up their real estate operations in Luxembourg because of the optimum entry and exit strategies that a Luxembourg platform offers. The Luxembourg regulatory framework has evolved at a rapid pace over the last two years in order to respond to emerging needs for capital and liquidity. The Securitisation Law of 2004 is another good example of an innovative product for originators of assets and claims to be securitised. Additionally, there are opportunities to set up Luxembourg structures for private equity groups and venture capital firms based outside Asia and investing in countries such as China. In 2005, about 1 billion dollars of private equity was invested into Chinese ventures. Investment categories range from consumer business to pharmaceuticals and high technology. Most economic analysts predict that this source of capital and financing will continue to increase in the future with new foreign groups being added to the list of those already in China. Again, the major private equity groups already use Luxembourg to structure deals via Sicars or other vehicles and no doubt this will extend to deals in China. What are the challenges for venture capital funds in China? Other than the language barrier it is no secret that Chinese enterprises have their unique way of operating and conceptualisation of share capital. The first ventures were indeed faced with enormous challenges such as lack of accurate information, shareholders’ rights and managerial experience in finance. In March 2006, the China Venture Capital Association (CVCA) published research carried out on the challenges of venturing in China. The report presented the seven vital disciplines for a successful investment in China. Probably the most important discipline is the “Guanxi”

or “social capital networks to access information and to establish and maintain business relationships”. This concept is completely different to the “western” way of doing business and without “Guanxi” a venture could fail very quickly. The report also identified other challenges relating to improving corporate governance, the protection of intellectual property, the ability to adapt to local constraints, adding managerial and technical value, the ability to optimise the exit strategy and navigating the complex political and regulatory environment. The first ventures were certainly very risky but the Chinese enterprises and state-owned enterprises are evolving in order to attract foreign ventures to fill the gap due to the absence of local capital. Another questions is, can Luxembourg play a role in pension funds of multinationals operating in Asia? Many multinationals have a pension fund in each country where they are established. This duplication may be optimised by a pension pooling approach, which Luxembourg offers. The assets held by different pension funds are managed on a pooled basis and should lead to quantitative (economies of scale and lower operational costs) and qualitative (monitoring and benchmarking) advantages. Pension funds also face the risk of mismatch between the current value of investments and the liability in defined benefits schemes. Luxembourg offers various products for liability driven investments (LDIs) in the form of portable alpha investment funds or guaranteed return investment funds. The Hong Kong SFC’s circular on UCITS III will allow Luxembourg funds to use derivatives and add the alpha returns. The Luxembourg investment fund industry has all the qualities to attract more investors from Asia. The development of a China-JapanIndia axis will help promote the Luxembourg funds in these countries and their neighbours. The Mittal Steel and Arcelor merger has put Luxembourg under the spotlight on the world stage. Let us use this momentum to get Asia to look at Luxembourg. || Johnny Yip

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STÉPHANE BADEY

MIFID: Fact versus Perception Is MIFID just another compliance issue? Interview with the Senior Legal Counsel for RBC Dexia Investor Services Bank.

What is the state of play? “On 30 June 2006, the European Commission published the latest text of MIFID Level 2 draft implementing measures. On 18 July 2006, the Commission of European Securities Regulators (CESR) issued its public consultation concerning Level 3 measures which relate to the process of ensuring consistent implementation across the EU. Locally, a first draft of the law, which will substantially amend Luxembourgish Law on the Financial Sector (5 April 1993), has been proposed. Where do investor service companies stand in relation to MIFID? “Custodian activities for collective investment funds and fund administration are specifically excluded from MIFID’s scope. On the other hand, shareholder services and distribution support services are fully in scope, qualifying as investment services. The Association of the Luxembourg Fund Industry (ALFI) has established a working group for industry providers to discuss potential issues that investor service providers could encounter during implementation. Application of MIFID rules, more specifically - appropriateness and best execution - in respect of shareholder service activity, has raised certain concerns. Shareholder service providers work for management companies that appoint them to maintain the funds’ registrar; such activity, in our view, is barely in scope. ALFI has signalled this standpoint to the Luxembourgish regulator. Even if the shareholder service activity benefits from an exemption, the best bet is to prepare ourselves in view of it being in scope, ready to comply by November 2007.

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

MIFID (Markets in Financial Instruments Directive), aims at providing a legislative framework that will result in creating a level playing field across European financial markets. While MIFID’s ultimate objectives are harmonisation, investor protection, high quality execution and increased transparency, to some, MIFID initially brings to mind increased costs. Faced with high cost forecasts from research organisations, RBC Dexia Investor Services Bank SA has put MIFID on its agenda at an early stage.

Stéphane Badey, Senior Legal Counsel for RBC Dexia Investor Services Bank

What are some of the challenges of MIFID regulation? “Although most third party administration core activities are not in scope, MIFID is a topof-mind subject because clients, partners and their clients will possibly be directly or indirectly affected. Third party administration clients will certainly be impacted because of their own client base. As service providers we must monitor their concerns, which are probably our biggest challenge. Several questions arise. For example, how will clients best demonstrate complete compliance with best execution? Likewise, how will they cope with new reporting requirements? Can investor service providers offer them the necessary support and information? How will their concerns be likely to affect our client service offer and create potential opportunities for new services? It is easy to think of MIFID as just another compliance issue. Indeed, MIFID will be a

challenge for financial market departments because of its potential to affect market structures across Europe. The requirement for best execution will certainly lead to an explosion of information, and, custodian banks may be well placed to deliver the required information. Reporting processes will be rethought and efforts to further adapt information to client demands will be bolstered. Likewise, one of MIFID’s goals is to facilitate the European “passporting” of investment services. Should MIFID really be a facilitator in this respect, this may create new opportunities. What are the next steps? “Twelve months from required implementation, forward-thinking investor service providers are conducting analyses in collaboration with their client base to best understand how to move forward in continued optimisation of their client services on offer and to adapt existing tools to meet their needs”. ||

Ernst & Young, a commitment beyond your expectations

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GLOBAL IM SURVEY

“Another key challenge is innovation” Interview with John Parkhouse, Partner at PricewaterhouseCoopers Luxembourg John, PricewaterhouseCoopers recently conducted the “Global Investment Management Survey 2006”. Could you provide us with some background? “This is the second time PricewaterhouseCoopers have conducted an investment management survey on a global scale. There were 81 investment management organisations of varying sizes and disciplines taking part from around the world, representing around nine trillion US dollars in assets under management. The answers to the survey were mostly supplied by Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs). In addition to the questionnaire-based part of the survey, we also ran a series of round table discussions and oneon-one meetings with senior executives. What do the survey results say about the current situation of the industry? “Since 2003, when we conducted our first Global Investment Management Survey, the business environment for investment managers has changed considerably. While 2003 was a difficult time and most participants concentrated on cost control and were rather pessimistic about their future, the overall picture is much brighter now. Revenues have risen, prospects for further growth in revenues are rather good and generally speaking the participants now clearly focus on growing their business through entering new markets and launching new products. What kind of products will they be launching? “The participants anticipate an increase in assets under management (AUM) of alternative products such as real estate funds, private equity funds and hedge funds. Their share of total AUM is expected to rise from 12% to 17% in the next three years. Consequently, almost half of participants plan to launch or increase their hedge fund offering and 30% are keen to offer more real estate and private equity funds.

Thus, the alternative segment will account for a materially larger proportion of revenues in three years according to the participants. Over half the participants are also planning to increase their offering of ‘traditional’ funds such as equity, fixed income and money market funds within the next three years. These products are expected to represent on average 78% of AUM in three years’ time, which compared with the current situation, is however a decrease of six percentage points to the benefit of the alternative segment.. So, can we expect the number of funds to grow in the future? What is the impact for Luxembourg? “Certainly. Although quite a number of people in the industry have been saying for a while now that there are too many funds around, especially in Europe, and that the industry needs to look at rationalisation and the issue of fund mergers; participants have included new products as part of their strategies to generate future growth. This is good news for Luxembourg as most international players are launching new types of funds from the Grand Duchy. However, there are other important sources of revenue that participants are also focusing on. These include entering new geographic markets and above all expanding the distribution in existing markets. This bodes well for financial centres like Luxembourg which are well positioned to function as hubs for international growth. Surprisingly though, few participants expressed confidence in their distribution capabilities, especially small and mediumsized investment managers. Large and very large companies were more confident here and more than half of them are looking into mergers and acquisitions to expand their business. What are the trends in fund distribution? “The answers suggest that participants expect existing sources of distribution to eventually consolidate, be it banks, financial advisors,

multi-managers or other. Regarding the distribution to retail clients, the Internet is considered by the participants to be an emerging distribution channel. With existing distributors consolidating, the respondents expect that increasingly powerful distributors will be in a position to demand higher fees. How do investment managers intend to distinguish themselves in their fight for space in the distribution channels? “In a phrase, the perceived way forward is ‘brand backed by substance’. This means that investment managers should have a strong, wellknown brand, with a good investment performance and a solid investment process. While both retail and institutional clients look at brand and performance, the quality of the investment process was mentioned as an important criterion to win mandates from institutional clients. A key success factor on the retail side is also the quality of the distribution arrangements in place. Although Luxembourg is not in the same investment management league as London, Paris or Frankfurt, it is clearly a European centre of expertise in the administration of investment funds. According to your survey, what are and will be the major operational issues? “While during the past three years the focus in operations was on improving operational effectiveness, participants said that in the future they will concentrate more on improving service quality. Major challenges for fund operations will include assuring compliance with numerous regulatory changes, recruiting and retaining the best employees and dealing with new asset classes and instruments like derivatives. Although the survey was conducted on a global basis, I believe the results also apply to fund operations in Luxembourg. Regarding IT investments, the survey participants said that the highest proportion of their budgets goes to portfolio modelling, expressing the need to improve

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Will Luxembourg third party service providers benefit from a growing trend towards outsourcing? “According to the survey results, participants expect strong growth in outsourcing over the next three years, mainly because many investment managers intend to concentrate on their core competencies. Consequently, the functions that tend to be outsourced include investor administration and servicing, investment operations and fund accounting. I think that a number of Luxembourg third party service providers are well positioned to benefit from this global outsourcing trend. However, it should be noted that quite a large proportion of participants considered the quality of services received from third party providers to be lower than those provided in-house. This excludes tax and custody services, though, with which the participants were quite happy. Service providers who get their service quality right will be in a strong position to attract outsourcing business. Do you see other opportunities for Luxembourg? “In the survey we found that CFOs are increasingly focusing on tax planning opportunities. Over the next three years, a significant proportion of participants will be paying more attention to tax strategy and tax risk. Although, surprisingly, survey respondents expressed little interest in VAT, the issues surrounding transfer pricing and global profit allocation were, on the other hand, high on the agenda of CFOs, especially those of large organisations. I think that Luxembourg should be more active in promoting the opportunities it can offer in this area.

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

the investment process and performance. The biggest increase in IT spending concerns customer relationship management. This is in line with what participants said about their strategic priorities in the future which include improving service quality.

John Parkhouse, Partner, PricewaterhouseCoopers Luxembourg

Finally, what will be the key challenges for the industry and Luxembourg in the coming years? “There are several important points to mention. On the product side, we observe that products and investment management styles are becoming more and more sophisticated, for example through the increased use of derivatives and the development of the alternative segment. This has repercussions on the administration side which will need to bring its processes and procedures in line to cater for these more complex products. In this context, risk management will need to improve compared with where it is now. The growing complexity and sophistication in

the industry requires highly skilled staff and I think that more emphasis will be put on training and retaining qualified people. Finding enough skilled persons is certainly the greatest challenge for Luxembourg today. The financial centre needs to work on a common approach for the development of local expertise and recruitment abroad in order to ensure a sustainable development of its activities. Another key challenge is innovation. After the rather heavy EU regulatory agenda of the recent past years, it is essential for the future of Luxembourg that the centre reposition itself as a pioneer in this industry and to demonstrate leadership through a strong process that delivers innovative products and services.” ||

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C H R I S T I A N G E L L E R S TA D

Changes looming on the horizon What are the main trends you currently see in the European fund distribution market? “With regards to distribution we expect the concept of open architecture to continue to grow. Open architecture, the possibility to buy the best third party funds at every bank, is a trend which cannot be turned around due to its strong support from customer demand all over Europe. Even markets like the Netherlands or the UK, which have a very competitive domestic fund industry and were hence regarded as closed for foreign funds, are now quickly opening up. With the concept of the European passport incorporated in the Management Directive, UCITS III will further help to promote panEuropean cross-border distribution. Already today distributors active in several European markets and offering a selection of excellent investment funds gain market share from the large local players offering everything to their domestic clients. This trend will further accelerate. It will also further lead to a separation of fund producers and fund distributors. Small and medium-sized banks will more and more have to decide whether they are producers of investment funds or sellers. You mentioned the impact of UCITS III on distribution. Do you also see an impact on product development? “Yes of course. As you know, UCITS III consists of two directives: the Management Directive and the Product Directive. We expect the impact of the Product Directive to be even more important on our industry. Besides the obvious impact of allowing cash funds, index funds and fund funds to become UCITS products there exists a second effect which will change the asset management industry even more. We expect a further alignment between the traditional long-only funds and the hedge fund world. UCITS III enlarges the use of derivatives and it widens the scope of eligible securities in UCITS funds. This will allow investment companies to launch UCITS funds with a risk-return profile similar to hedge funds. The borders between long-only products strictly focused on a benchmark on the one side and hedge funds will get blurred. The two approaches will continue to exist but the grey zone will become larger. In the area of absolute return funds we have already seen a number of

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

The investment fund industry continues to evolve, but what are the trends? Initiatives such as the European passport, the concept of open architecture, and UCITS III are going to have an impact on fund distribution and product development.

Christian Gellerstad, Group Managing Director Pictet & Cie (Europe) SA Luxembourg

new launches specifically exploiting the new possibilities; in particular by using derivatives in order to replicate a market exposure. This trend will continue. Besides UCITS III, what are the main drivers for change in the investment fund industry in Europe? “The decreasing ability of public pension provision schemes to provide reliable assurance for old age will further result in an increase of private savings in Europe. The ultimate goals of such investors are asset preservation and riskcontrolled asset growth. In the future, these elements will attract much more attention from buyers and producers of financial products and will eventually become product features. Banks and insurers will try to fill this gap with products responding to the specific needs of such clients; life cycle funds, absolute return funds, capital guaranteed funds are just a few examples to name here. In this context we expect funds to play an important role either as core product or as building blocks. Funds are the ideal invest-

ment instrument for long-term oriented savers since they perfectly combine transparency, flexibility and security. Another driver is increased cost transparency enforced by financial authorities all over Europe. This trend forces fund providers more and more to clearly display what value they are creating for the fees they charge. Professional fund investors, like banks and insurance companies and increasingly also pension funds, will either buy very active funds or index funds. With active funds the investor buys the investment competence of a manager and expects him to clearly deviate from a benchmark by strongly over- or under weighting stocks. For such products, provided they deliver a sustainable extra-return, investors will still be ready to pay an active management fee. If the investor prefers a simple exposure to the market he will buy passive products with low costs. Hence we expect active products with low tracking errors which try to ‘hide’ behind the benchmark to disappear form the market.” ||

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N AT H A L I E D O G N I E Z

The evolving regulation of hedge funds in Europe A year ago, the ECB President, Jean-Claude Trichet, told the European Parliament that he was adamant that any future regulation of hedge funds must be global in its scope and application. He said that the “rapid evolution” and “immense explosion” of hedge funds required “better understanding”. At the same time Charlie McGreevy, EU Commissioner for Internal Market and Services said, “European hedge funds regulation should be the responsibility of individual EU member regulators”. Indeed, regulators have been making a few high profile moves in the context of hedge funds on both sides of the Atlantic over recent years. The impetus for the regulatory measures has come in part from the significant growth in assets managed by hedge funds. New institutional investors such as pensions, charities and insurance companies have increased their allocation to hedge funds, and there is growing interest by retail investors in the asset class. The involvement of hedge funds in some market timing inquiries in the US has no doubt hastened the introduction of new regulatory measures affecting the sector by the SEC. Regulators in the US and the UK, the two biggest centres for hedge fund management, are treading the fine line between too much and too little regulation. Both are increasing the degree of monitoring and oversight. Around the world, different regulators and legislators have reacted to the industry in different ways, ranging from a warm welcome to accusations of predatory behaviour. Some have demanded global regulation, however, this seems a long way away. Developments at EU level At European level, in January 2004 the European Parliament adopted a resolution on the future of hedge funds stating that they now consider it timely to develop a light-handed and appropriate EU-wide regulatory regime for sophisticated alternative investment vehicles (SAIVs). The regime would help to attract SAIVs to the EU and would provide the benefits of a

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

As long as the EU fails to introduce a general regulatory framework, Europe will be characterised by a patchwork of local regulations with one underlying theme, the prevention of distribution to certain categories of investors.

Nathalie Dogniez Partner, KPMG Audit

common European passport by means of mutual recognition. The reason for developing the regime is that the parliament considered it opportune to facilitate access to SAIVs for moderately affluent investors and plans in due course to provide access to retail investors when awareness and understanding of hedge funds improves. The latest UCITS amendments in 2002 widened the scope of eligible investments to include financial derivative instruments and units in funds. As a result, it permits the sale of hedge fund-like products to the European retail investor community, and many leading managers have taken advantages of this. Still, given the restrictions on leverage and the prohibition of short selling, many strategies still fall out of scope. Moreover, funds of hedge funds, while open to retail investors in an increasing number of EU

countries, do not benefit from the European passport and it seems that EU regulators do not favor UCITS taking indirect exposure to the hedge funds sector through the use of hedge fund derivatives. In the individual Member States In the absence of an EU-wide regulatory framework, we have recently seen several European countries adopt special regulatory regimes to encourage hedge funds to set up in their jurisdiction as well as new regulations in the more mature hedge fund jurisdictions. For instance, in Ireland hedge funds have been set up for several years under the professional investor fund (PIF) or a qualifying investor fund (QIF) regulatory framework. A PIF has a minimum investment requirement of

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125,000 euros and the investment restrictions applicable to retail funds are relaxed through derogations granted by the IFSRA. A QIF has a minimum investment requirement of 250,000 euros but there are no limits on the investment objective, policies, restrictions, or leverage that a manager of a QIF can employ. In December 2002, the IFSRA added retail funds of hedge funds with no minimum investment to the suite of alternative investment products regulated in Ireland. Italian hedge fund regulation has been in existence since 1999 with the appearance of the speculative funds (fondi speculativi) category of investment fund. Since 2003, the rules applying to speculative funds cap investors at 200, with a minimum investment of 500,000 euros and the hedge fund has total dispensation from the Bank of Italy restrictions and prudential rules on risk concentration. Furthermore, the hedge funds must be managed by management companies that exclusively manage hedge funds. While the Italian regulation imposes a maximum number of investors, on the other hand the recently introduced Spanish regulation imposes a minimum number of investors. The FSA is reviewing its approach, in consultation with the industry at large, and has hinted that some limited access may be given to retail investors. We could also enumerate the German regulation (2004), developments in Denmark, the new ARIA (fonds agrées à règles d’investissement allegées) regime in France, etc. Closer to us, Luxembourg has been a domicile for alternative products since 1991 with the release of Circular 91/75. The regulatory framework was enhanced in 2002 with a new Circular 02/80 clarifying the rules applicable to hedge funds and funds of hedge funds. The particularity of this regime is that there is no minimum investment limit and no restrictions to certain categories of investors and accordingly the hedge funds and funds of hedge funds can be distributed to the public. The reg-

ulator does place a lot of importance on the experience, reputation and financial standing of the promoter as well as the investment manager in approving these fund products. The risks are limited through limits on overall leverage and risk diversification rules. In June 2004, the hedge fund sector received another boost with the opening to listing on the Luxembourg stock exchange to foreign hedge funds. This regime has proven very successful as, per ALFI statistics, Luxembourg is now the first European domicile of hedge funds, with a total of 621 funds amounting to 66 billion euros (ALFI statistics, 31 December 2005). The expert report On 4 July 2006, The European Commission published three industry reports that analysed the EU fund industry. These reports are a result of the European Commission appointing experts to two groups on investment fund market efficiency and alternative investments. These groups were responsible for analysing ways in which the European fund sector could be improved. The reports were prepared as follow-up action to the Green Paper on the enhancement of the EU framework for investment funds and long-term savings vehicles. The reports and the reactions to them will feed into the Commission’s White Paper on strengthening the single market framework for investment funds scheduled for publication in November 2006. The reports look at the various challenges that are facing the different segments of the EU investment fund industry. The focus of these reports is on three main asset classes: UCITS, hedge funds and private equity. The report on hedge funds proposes a number of approaches, which do not require new EU legislation in order to make hedge funds available to different classifications of investors. It points to the need to further develop access to investments in hedge funds by institutional investors and to the provision of support services to hedge fund managers on a cross-border basis.

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The recommendations of this report may be summarised as follows: 1- Regulators should not seek to control sales and distribution of hedge funds through product regulation and registration. Regulators should focus, instead, on preventing access to hedge funds by investors for whom such investment is not suitable (for instance, introduce a minimum threshold of 50,000 euros) and enforcing clear conduct of business requirements on intermediaries and distributors. 2- It is not the right time to re-open discussions on allowing funds of hedge funds within the UCITS directive. 3- UCITS investment in derivatives based on hedge fund indices should be deferred until concerns regarding the structure and performance of hedge funds indices are resolved. 4- Mutual recognition amongst Member States of (nationally regulated) retail-oriented hedge fund products, which would be distributed under MIFID conditions. 5- Removal of any arbitrary and/or regulatory prohibition or restriction on hedge fund investing imposed on some institutional investors. 6- Measured and appropriate implementation of the Capital Requirement Directive. 7- Negotiation between European Union and US SEC in order to secure exemption from the US registration requirements for European hedge fund managers who are already registered with a Member State authority and are doing business with US qualified investors. 8- Custodian bank should be a regulated provider of custody services, either domestically or in another Member State together with a minimum assets requirement. 9- Reduction of regulatory discrepancies amongst Member States regarding custody requirements. 10- No restrictions upon re-hypothecation limits or, if a ceiling is considered necessary, it should be based on the level of indebtedness (rather than NAV) and coupled with close-out netting provisions. Moreover, prime brokers regulated in one Member State should be entitled to provide prime brokerage services to hedge funds domiciled in another Member State. 11- No regulation on hedge fund valuation but a system of best practices coupled with trans-

parency for investors, allowing them to appreciate the level of independence of the valuation function and the methodology applied as part of the due diligence conducted prior to investing. While recommendations 2 and 4 will not favour the current movement of convergence between traditional products and hedge fund strategies, proposition 4 opens new perspectives for the retail-oriented regulated Luxembourg domiciled hedge funds. The future The big challenge for regulators today is to answer whether hedge fund type products should be accessible to retail consumers to broaden their investment universe and if so, how? There is the realisation that retail investors may already be directly accessing hedge funds today without any specific protection via stock market listings or indirectly via structured notes, insurance products, hedge funds index-linked products or funds of funds. Regulators are particularly concerned about areas such as valuations of less liquid investments such as OTC derivatives, distressed debt and asset-backed securities and the impact of any mis-statements in valuations, and there is also increased focus on sound corporate governance for funds. At a national level, many regulators are making changes to the regulatory framework governing the creation and distribution of hedge funds, a trend that is set to continue now that the alternative class has come to the mainstream. However, as long as the EU fails to introduce a general regulatory framework, Europe will be characterised by a patchwork of local regulations with one common underlying theme, the prevention of distribution to certain categories of investors (apart from Luxembourg products, that instead emphasise the reputation and experience of the investment manager and promoter). Given the fact that investors have indirect access to hedge funds as mentioned above, we can certainly question whether investor protection will be achieved via product distribution restrictions or if the grounds for investor protection should be to focus on rules in relation to investment advice, such as MIFID requirements, and efforts on investor education. || Nathalie Dogniez, Partner, KPMG Luxembourg

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DR WOLF KLINZ

â&#x20AC;&#x153;Dark clouds on the horizonâ&#x20AC;? The European fund market is booming. Its annual growth rate between 1994 and 2004 has been around 14%, the asset growth between 2004 and 2005 alone totalled 905.6 billion euros. The total net assets invested in 2005 summed up to 4,618.8 billion euros. UCITS is a brand name not only within Europe but worldwide. It is sold in Singapore, Hong Kong, Taiwan, Chile and many other countries. Although the future seems bright, there are dark clouds on the horizon. Since the internal market does not function properly yet, the European industry risks losing its competitiveness in the increasingly global market. If no action is taken, and quickly, the European Union risks the paralysis of its asset management industry in the future. On a more positive note, one could say that the industry still has the potential for further consolidation and growth as markets in the EU are still not fully integrated. Looking at the numbers, only 18% of all funds are truly crossborder funds. Significant barriers still hinder companies from working on a cross-border basis and from offering the same product in different countries. There is therefore a wide range of products on offer, one may even say too many (three times as many as in the US), but consumers cannot profit from this choice given the lack of cross-border funds and cross-border offers. Furthermore, the size of the investment funds is sub-optimal: US funds are five times bigger than EU funds. For all these reasons potential economies of scale cannot be exploited, placing Europe at a competitive disadvantage in the global environment. Fortunately, all stakeholders have realised that a strong, integrated and efficient European capital market would be beneficial for every-body. That is why they have started to work constructively together towards achieving this goal.

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

Despite encouraging growth, some industry professionals think that the European fund industry could suffer in the global market if it doesnâ&#x20AC;&#x2122;t quickly get its act together.

Dr Wolf Klinz, MEP, ALDE Coordinator for Economic and Monetary Affairs, Rapporteur of the European Parliament on Asset Management

The starting point is the UCITS Directive of 1985. Its overall objective was to create a wellfunctioning single European market thus ensuring the best possible product/service offerings for the consumer, enabling the industry to increase its productivity through cross-border activities and improve its competitiveness to the highest possible level in the global context. In addition, it had been hoped that useful steps of consolidation could be taken with the constructive support of the supervisory bodies thus making sure that the industry would remain strong and attractive. These objectives have not been fully achieved. The directive has not been a failure, but there is certainly room and maybe even urgent need for

improvement. In addition, over the years markets have changed at an incredible and unforeseeable rate resulting in the introduction of constantly new products. These developments, of course, have not been anticipated in the directive. Seeing the need for action, the Commission published a Green Paper in summer 2004 to start a discussion process among all stakeholders that have been invited to actively participate in developing guidelines for the future development of the industry. More than 100 inputs were sent to the Commission on this subject. The European Parliament discussed the issue intensively over several months. As the rapporteur of the European Parliament, I was at the

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centre of this debate. In April 2006, the plenary adopted a resolution based upon my conclusions that the Committee for Economic and Monetary Affairs had already strongly supported. The Parliament has chosen a practical approach, which promises necessary improvements within a relatively short period of time. This approach builds on common efforts and actions of all players: industry, supervisors, and legislators. First and foremost we need to work together and trust each other. This includes (in particular) an intensive dialogue and cooperation of all supervisors. Industry can contribute with own-initiatives (e.g. in the field of fund processing standardisation). In our view though, the following targeted legislative changes are necessary (most of them short term): - The true harmonisation of the so-called simplified prospectus would ensure that brief, standardised, understandable and comparable information would be provided to the investor in his native language. - A regulator-to-regulator approach for the notification would overcome the present de facto authorisation procedure which was never the intention of the legislators in the first place, but has evolved and degenerated in practice over the years. Although the final guidelines of CESR on notification dated 29 June 2006 limit the period for notification, they still fail to establish a real regulator-to-regulator approach. - By enhancing harmonised rules for management companies a real management company passport can be achieved. - The possibility to delegate pure custody functions on a cross-border basis would create more flexibility for companies provided that the question of legal liability is clearly resolved. However, in my view the introduction of a depositary passport does not seem to be feasible in the short term. The precondition for its cre-

ation, namely the harmonisation of the role and responsibilities of the depositor, has not been met yet. A close cooperation between supervisory authorities is necessary to facilitate convergence and make harmonisation possible in the longer term. - A new legal basis for cross-border mergers in order to eliminate current obstacles has to be developed. A point of reference can be the principles set out in the directives on crossborder mergers of limited liability companies and on taxation of mergers. Greater regulatory convergence in pooling (entity and virtual) shall be achieved by intensive contacts and cooperation of all supervisors. In order to allow for the introduction of the master-feeder structure a legislative change is necessary. - As for assets eligible for the UCITS, CESR advice on eligible assets for investment is a step in the right direction: listed real estate investment trusts, private equity funds and certificates are included among the eligible assets. Nevertheless the discussion will continue whether or not funds of hedge funds, hedge funds, hedge fund indices as well as property funds should be included. Enlarging the list of eligible assets could require a change in the directive. - In order to ensure a flexible legal framework, the review of the UCITS Directive has to apply Lamfalussy principles on the articles that may be amended. Such an approach would be a practical solution allowing for the necessary flexibility and rapidity in reactions to market developments. Recently, three expert groupsâ&#x20AC;&#x2122; reports were published: on alternative investments (in particular hedge funds), private equity, and the efficiency of the investment fund market. In the context of UCITS, the following aspects of these reports should be highlighted: as to eligible assets, the expert group on alternative investments did not recommend for funds of hedge funds and hedge fund indices to be included in

the short term. On other subjects, the recommendations of the expert group on market efficiency were very close to the position of the European Parliament. In particular, the experts group asked for the following changes: creation of a short time line for the notification procedure, establishment of a simplified prospectus with key disclosures, enabling fund mergers by eliminating the current tax obstacles, enabling master-feeder and other forms of entity pooling, building a common understanding between regulators on virtual pooling, enabling the choice of a foreign depositor, making the management company passport work and enabling the management company to provide services on a cross-border basis. It is up to the Commission to finalise and deliver the White Paper in autumn 2006. Any deliberation of change will be a step forward, but concrete proposals for legislative changes must follow soon. The need for improvement in the areas mentioned above is urgent. Certainly there will be an agenda set up with short-, medium- and long-term actions. The outcome of discussions on some medium- and long-term issues is still uncertain. This is particularly the case in the area of distribution, the subject on which Eurofi will conduct a study that should produce results by the end of the year. It can only be hoped that a constructive dialogue will bring us forward on these issues. My personal vision is clear: in a well-functioning single European market investors will be offered best possible products under attractive conditions that will help them meet their saving needs and provide for old age. European industry will remain a global player and even become a highly productive competitive global leader. Step by step and hand in hand, indeed, we have all the ingredients to make this work and to create a unique success story â&#x20AC;&#x153;Made in Europeâ&#x20AC;?. || Dr. Wolf Klinz

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MAJOR CHANGES FROM A CSSF POINT OF VIEW

Increasing sophistication Mrs Delcourt, the worldwide fund industry is facing perpetual changes, evolutions, new products and new trends. What are the major changes you have noticed recently in the Luxembourg fund industry? “I would say that there are two major changes. Firstly, Luxembourg ‘fund products’ have become increasingly sophisticated, as they invest in derivatives or securities with embedded derivatives to a larger extent. This phenomenon has to be put into the following context: the Luxembourg fund industry has developed its specialisation continuously; UCITS III has enlarged the eligible assets for investment funds thus opening the European Union market to a larger number of funds which could be distributed on a cross-border basis; fund products are in competition with other highly sophisticated investment products which are not subject to the same investor protection; and finally, investors in financial products have become more educated and shown greater interest to invest in sophisticated products. Secondly, the fact that the Luxembourg fund industry had to cope with the substance requirement imposed by the UCITS III Directive should also be mentioned. I am of the opinion that this new requirement had a positive impact on the way the funds are supervised and managed by the pesons who effectively conduct the fund’s business. Talking about UCITS III, how about the actual stage of the conversion from funds issued under the UCITS I to the UCITS III Directive? “I am very satisfied that up to now the conversion process of UCITS I funds to UCITS III funds has been achieved within the deadlines set by the CESR guidelines for supervisors regarding the transitional provisions. As for the remaining funds, which still benefit from the grandfathering until 13 February 2007, I am confident that the deadline will be met. Is there a specific issue the CSSF has to keep an eye on in the near future in the context of the UCITS III Directive? “Since the implementation of the UCITS III Directive by the Luxembourg law dated 20 December 2002 relating to undertakings for collective investment, the fund industry has made a

Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

Interview with Simone Delcourt, Director, Commission de Surveillance du Secteur Financier (CSSF)

Simone Delcourt, Director, Commission de Surveillance du Secteur Financier (CSSF)

lot of effort to comply with the new regulation. From the CSSF’s point of view, there certainly are further efforts the fund industry has to make, particularly in relation to risk management. The CSSF noticed that not all the actors of the fund industry are fully aware of the importance of a proper risk management. The European Union objective is to further reconcile the financial legislation of the Member States. In this context, what are the implications of the new “Markets in Financial Instruments Directive” (MiFID) on the fund industry? “The CSSF and ALFI are currently analysing the impact of MiFID on the fund industry. What we can say for the moment is that MiFID will have an impact on certain financial professionals active in the fund business. It is not always entirely clear which trades are subject to MiFID regulations and which are subject to UCITS alone. But what seems certain is that the

distribution structure through which Luxembourg funds reach end investors will fall within the scope of MiFID in terms of arranging deals and providing advice. A last question Mrs Delcourt, how do you see the future evolution of the Luxembourg fund industry? “I think that the recent performance of the Luxembourg fund industry as well as its continuous adaptation in a changing world clearly shows that the industry still has a bright future ahead. The development of new products and a growing specialisation among service providers will contribute to the expansion of the industry. I would however, like to repeat, as I have already done on other occasions, that to assure the success of the Luxembourg fund industry, all the actors have to work hard in order to stay competitive on the international fund market.” ||

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Illustration: Jorge Rodriguez-Gerada (www.creativehothouse.com)

Hermann Beythan and Emmanuel-Frédéric Henrion, Partners, Linklaters Loesch

E M M A N U E L- F R É D É R I C H E N R I O N A N D H E R M A N N B E Y T H A N

Luxembourg, the pan-European platform for real estate funds The last few years have seen a spectacular increase in the number of regulated real estate investment funds. Luxembourg has become the preferred jurisdiction for such funds investing across Europe. On 30 June 2006, 42 real estate investment funds were officially registered with the CSSF which comprise 51 sub-funds in aggregate. To our knowledge, a significant number of new investment funds have been approved by the CSSF (Commission de Surveillance du Secteur Financier) since the end of June and many real estate investment fund projects are in the pipeline. Although there are no official detailed statistics to enable a breakdown across investment styles, asset classes and location of properties, it is fair to say that Luxembourg real estate funds cover the full range. Funds adopting a pure core strategy have been followed by core plus funds, added value funds and more recently opportunistic funds. Asset classes cover all types of commercial real estate, such as offices, retail units, warehouses, shopping outlets, car parks, etc. In terms of geographical location of the properties, typical investments of Luxembourg real estate funds were initially made in western Europe, notably France, Spain, Italy and Germany, followed by investments in central and eastern Europe. More recently we have seen investments in real estate in Asia. FCPs (fonds commun de placement) represent 69%, SICAVs (société d’investissement à capital variable) 24%, and the remaining 7% consist of other legal forms (e.g. société d’investissement à capital fixe). Indeed, an FCP as a contractual structure offers certain flexibilities as compared with a SICAV (a corporate structure), notably with respect to the participation of investors through advisory investor committees. This type of investment fund is also well known in the market and, in particular, the banks providing credit facilities are familiar with it.

Most of the 42 funds are closed-ended and almost 75% of the 42 funds are reserved to institutional investors under the 1991 law1. It appears from these statistics that the benchmark real estate fund is still the closed-ended FCP reserved to institutional investors. A relatively new product is a fund of real estate funds. Out of the 42 funds, four are already funds of real estate funds. This indicates that the market for real estate funds has matured and reached a critical size, so that asset managers can pursue asset allocation strategies, choosing among various investment strategies and asset classes. This further provides the opportunity for asset managers to offer to their customers highly diversified products.

The underlying economic drivers Diversification and liquidity are the two main drivers for real estate funds. Diversification is key for portfolio managers and investors. This is an obvious statement and not a new one but it is crucial. Since Markovitz in 19592, the benefits of diversification are well known. In substance, diversification provides a significant reduction in the risk level of a portfolio while maintaining the highest possible expected return. Efficient diversification can be achieved by analysing correlations between available investments and more particularly by taking advantage of low (and sometimes negative) correlations between various asset classes. From that perspective real estate is a very attractive asset class because real estate returns are relatively uncorrelated to returns on traditional asset classes, namely equities and bonds.

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Since the dotcom bubble burst in 2000, both retail and institutional investors are looking increasingly for absolute returns and reliable growth. Hence the current trend to further refine investment strategies by improving diversification through the inclusion of alternative asset classes, such as real estate, and through an enhanced use of derivatives to structure the payout profile of investment portfolios. Liquidity is the second main driver, closely related to the diversification driver. Diversification makes more sense for investors and is more easily achieved if the assets comprising the portfolio are liquid so that the said portfolio can be rebalanced and actively managed in an efficient manner. Real estate investment funds play a crucial role in this respect by transforming real estate, which is generally viewed as an illiquid asset class, into a more liquid asset class, namely investment fund units, that are more easily transferable.

Luxembourg real estate investment funds may be constituted either under the 19 July 1991 law on undertakings for collective investment for institutional investors or Part II of the 20 December 2002 law on undertakings for collective investment. 2 Markowitz, H., Portfolio Selection: Efficient Diversification of Investments, Wiley, 1959. 1

Further growth The two main economic drivers, diversification and liquidity as discussed above, will continue to drive the sustainable growth of the real estate investment fund market. Given the now well established track record of Luxembourg as a domicile for international real estate investment funds and the unrivalled expertise that goes with it among the Luxembourg service providers (e.g. custodians, central administrators, auditors, tax advisers and legal advisers), Luxembourg is well placed in this respect. However, Luxembourg must not rest on its laurels but continue its efforts to provide a competitive environment. We may mention in this context that, in a recent circular, the CSSF clarified the rules under which a SICAR (société d’investissement à capital risque) can be used as a tool for real estate investments. Also the revision of the 1991 law will provide additional flexibility. Even though Luxembourg real estate investment funds are currently primarily offered to institutional investors, this product will in the future be offered more and more to sophisticated investors and even to retail investors. To achieve this goal the key success factor will be the liquidity of Luxembourg real estate investment funds. Liquidity can be achieved either inside the fund structure by moving from closed-ended funds to open-ended funds, or outside the fund structure by a listing, creating a liquid secondary market on which the fund’s units can be traded or the establishment of feeder vehicles investing in the master real estate fund. Needless to say, the structuring of open-ended real estate funds requires considerable attention and a credible mix of features and mechanisms sustaining the liquidity of the fund’s units. Such a mix includes, notably, a more diversified investment policy in properties and liquid assets, credit facilities for liquidity purposes, a facility for the postponement of redemption orders and prior notice requirements applicable to redemption requests. The related issue is obviously the valuation of the underlying investments, the determination of the NAV and the trading of the fund’s units on the basis of the prevailing NAV. Luxembourg service providers will play a more and more important role in this process, capitalising on the know-how they have been building up over the years. Listings in Luxembourg and abroad, master and feeder structures as well as registrations with foreign regulators for public distribution are already part of the structuring of Luxembourg real estate funds. It is also expected that additional real estate funds of funds will be launched. Such structures have certain inherent advantages. Finally, one may expect that property derivatives which are already actively traded in the United Kingdom will be used by more traditional funds, possibly combined with property financial indices and this will establish a bridge between alternative funds and traditional funds, including UCITS. || Emmanuel-Frédéric Henrion and Hermann Beythan

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Seite 44

GERARD OPRINS & MICHAEL FERGUSON

“Europe must act quickly to remedy the hurdles to progress” Gerard Oprins, Partner, Ernst & Young LLP, Chicago Michael Ferguson, Partner, Head of Asset Management, Ernst & Young Luxembourg

Because of its vast cultural and financial diversity, Europe has a unique opportunity to be at the forefront of the explosive worldwide growth of investment funds. Unfortunately, this very attribute could just as likely prove to be Europe’s greatest challenge when it comes to taking advantage of innovation in the industry. A priority must be to get products to the market more quickly and efficiently – achieving a single EU funds market is clearly vital to healthy cross-border competition. The July 2006 Report of the Expert Group on Investment Fund Market Efficiency summarises the main challenges and identifies potential solutions, but now action must be taken. Execution is key. The reality is that execution is more deliberate – and thus takes more time – in the EU than in the US. Sometimes this can be a benefit, as when careful consideration uncovers discrepancies that otherwise would not have come to light. But this deliberation can also be an impediment to action; failure to keep up with a dynamic marketplace can ultimately rob investors of the ability to capitalise on opportunity. Therefore, quicker execution of these recommendations is crucial. Many of the recommendations outlined by the Expert Group are contingent upon each

other, however one in particular can get the others to fall into place and help drive lower costs and market efficiency. The ability to merge UCITS of all kinds, including crossborder and national, without negative tax consequences. Fewer funds in the market will reduce confusion, as well as increase per-fund asset size – thus lowering operating costs, which can benefit the ultimate investor. By reducing tax consequences as well as consolidating regulatory oversight, the value proposition across all barriers identified by the Expert Group increases exponentially. The involvement of fewer regulatory bodies should also help to get products to the market more quickly by mitigating time and cost spent preparing lengthy documentation to satisfy each separate member state’s regulatory requirements. This is not to say that regulatory approval would not be required; rather, one regulatory body (e.g. regulatory body of home country) would have the full authorisation and responsibility to ensure the products are appropriate for the market – somewhat similar to the SEC. Pooling – which optimises resources and lowers costs by allowing manufacturers to commingle products for investment management – can flourish without the undue burden of cost-

ly, fragmented taxation. Important economies of scale and specialisation could be achieved in multiple-product environments across EU borders without unnecessary costs that dull competition and diminish investors’ net returns. The management company passport, designed to enable an investment manager with UCITS in multiple jurisdictions to centralise management company activities, should be made to work as it was intended in the absence of undue regulations. By providing the company freedom of a life beyond the borders of its home country, the passport can facilitate a better control environment and also foster economies of scale by allowing the management company to pool resources in the region most appropriate to its business. Finally, an alleviation of negative regulatory requirements will help grant more freedoms for the depositary. Originally, the depositary was entrusted with safekeeping of UCITS assets as well as oversight of the asset – both functions that help sustain a high level of investor confidence. Currently, the custody function is similar across EU member states. However, the control function is widely diverse, and the differences are increasing. According to the Expert Group, there should be greater flexibility both in relation to the types of entities that are permitted to provide depositary services and in the way in which such services are provided. This, in their view, will facilitate cross-border fund distribution, increase investor acceptance, improve risk mitigation, reduce costs and increase confidence. Europe will only be able to keep pace with the global growth in investment funds by acting quickly to remedy the hurdles to progress. Execution is key, and the pivotal barrier to true globalisation remains tax and regulatory harmonisation across European member states. Once this has been attained, European capital markets will be on a path to working efficiently and optimally, yielding the greatest returns for investors. || Gerard Oprins and Michael Ferguson

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MASTHEAD

INDEX

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ALFI 3, 8, 20, 28, 34 Bloomberg 22 BNP Paribas Securities Services 4 Caceis 11 Canon 17 Capital Group Cos. 22 CC Lux 45 CESR 28, 38 Columbia Management 22 Committee for Economic and Monetary Affairs 38 CSSF 40 Deloitte 26 EFAMA 20 Ernst&Young LLP, Chicago 42 Ernst&Young, Luxembourg 29, 42 European Commission 20, 34, 38 European Parliament 34,38 European Union 3 Fidelity 22 Fortis Banque 33 HR One 41 IFBL 8 IFIC 22 IIFA 22 IQ SOlutions 37 Kaupthing Bank 15 KPMG 2, 34 Luxembourg Government3 Luxembourg Stock Exchange 34 Midis 22 NICSA 3, 8, 20 Nordea 25 Olympic 22 Oppenheimer Funds 22 Pictet & Cie (Europe) SA Luxembourg 32 Putnam 22 PwC Luxembourg 30 RBC Dexia Investor Services 28, 48 Robert Walters 45 Retirement Learning Center 22 Royal Bank of Scotland 21 SEC 34 Standard & Poor's 22 Sungard 22 T. Rowe Price 22 Tata Consultancy Services 6 Ticoon 22 Vanguard 22 Victor Buck Services 13

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